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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
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Commission file number 001-31539
ST. MARY LAND & EXPLORATION COMPANY
(Exact name of registrant as specified in its charter)
Delaware 41-0518430
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
1776 Lincoln Street, Suite 700, Denver, Colorado 80203
(Address of principal executive offices) (Zip Code)
(303) 861-8140
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark whether the registrant is an accredited filer (as defined
by Rule 12b-2 of the Exchange Act). Yes [ X ] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
As of May 12, 2003, the registrant had 31,506,021 shares of common stock, $0.01
par value, outstanding.
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ST. MARY LAND & EXPLORATION COMPANY
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INDEX
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Part I. FINANCIAL INFORMATION PAGE
----
Item 1. Financial Statements (Unaudited)
Consolidated Balance
Sheets - March 31, 2003 and
December 31, 2002.......................................3
Consolidated Statements of
Operations - Three Months Ended
March 31, 2003 and 2002.................................4
Consolidated Statements of
Cash Flows - Three Months Ended
March 31, 2003 and 2002.................................5
Consolidated Statements of
Stockholders' Equity and Comprehensive
Income - March 31, 2003
and December 31, 2002...................................7
Notes to Consolidated Financial
Statements - March 31, 2003.............................8
Item 2. Management's Discussion and
Analysis of Financial Condition
and Results of Operations..............................14
Item 3. Quantitative and Qualitative Disclosures
About Market Risk......................................25
Item 4. Controls and Procedures................................26
Part II. OTHER INFORMATION
Item 1. Legal Proceedings......................................27
Item 2. Changes in Securities and Use of Proceeds..............27
Item 6. Exhibits and Reports on Form 8-K.......................27
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ST. MARY LAND & EXPLORATION COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share amounts)
March 31, December 31,
------------ ------------
ASSETS 2003 2002
------------ ------------
Current assets:
Cash and cash equivalents $ 17,291 $ 11,154
Short term investments 2,511 1,933
Accounts receivable 68,046 35,399
Prepaid expenses and other 5,739 6,510
Accrued derivative asset 3,822 -
Refundable income taxes - 1,031
Deferred income taxes 4,155 3,520
------------ ------------
Total current assets 101,564 59,547
------------ ------------
Property and equipment (successful efforts method), at cost:
Proved oil and gas properties 789,043 683,752
Less accumulated depletion, depreciation and amortization (263,725) (263,436)
Unproved oil and gas properties, net of impairment
allowance of $9,290 in 2003 and $8,865 in 2002 56,475 47,984
Other property and equipment, net of accumulated depreciation
of $3,748 in 2003 and $3,586 in 2002 4,329 3,639
------------ ------------
Total property and equipment 586,122 471,939
------------ ------------
------------ ------------
Other noncurrent assets 6,668 5,653
------------ ------------
------------ ------------
Total Assets $ 694,354 $ 537,139
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 74,936 $ 48,790
Accrued hedge liability 15,082 8,707
------------ ------------
Total current liabilities 90,018 57,497
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Noncurrent liabilities:
Long-term credit facility 71,000 14,000
Convertible notes, net of unamortized portion of
initial contingent interest derivative 99,625 99,601
Deferred income taxes 67,785 60,156
Asset retirement obligation liability 23,734 -
Other noncurrent liabilities 9,918 5,727
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Total noncurrent liabilities 272,062 179,484
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Commitments and contingencies
------------ ------------
Minority interest 700 645
------------ ------------
Temporary equity (Note 7):
Common stock subject to put option, $0.01 par value
issued and outstanding - 3,380,818 shares in
2003 and -0- share in 2002 71,594 -
Note receivable from Flying J and Big West (71,594) -
------------ ------------
Total temporary equity - -
------------ ------------
Stockholders' equity:
Common stock, $0.01 par value: authorized - 100,000,000
shares;
issued - 29,060,539 shares in 2003 and 28,983,110 shares
in 2002
outstanding - 28,057,839 shares in 2003 and 27,973,210
shares in 2002 291 290
Additional paid-in capital 142,066 140,688
Treasury stock - at cost: 1,002,700 and 1,009,900 shares in
2003 and 2002, respectively (16,057) (16,210)
Retained earnings 215,309 182,512
Accumulated other comprehensive loss (10,035) (7,767)
------------ ------------
Total stockholders' equity 331,574 299,513
------------ ------------
------------ ------------
Total Liabilities, Temporary Equity and Stockholders' Equity $ 694,354 $ 537,139
============ ============
The accompanying notes are an integral part
of these consolidated financial statements.
-3-
ST. MARY LAND & EXPLORATION COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share amounts)
For the Three Months Ended
March 31,
--------------------------
2003 2002
------------ ------------
Operating revenues:
Oil and gas production $ 95,688 $ 41,093
Gain (loss) on sale of proved properties 36 (36)
Marketed gas revenue 3,775 505
Other oil and gas revenue 1,445 350
Gain on sale of KMOC stock - 836
Derivative gain 115 -
Other revenues 145 25
------------ ------------
Total operating revenues 101,204 42,773
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Operating expenses:
Oil and gas production 21,130 14,030
Depletion, depreciation and amortization 18,885 13,054
Exploration 4,150 6,916
Abandonment and impairment of unproved properties 919 697
General and administrative 6,146 3,141
Derivative loss - 352
Marketed gas system operating expense 3,359 424
Minority interest and other 196 377
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Total operating expenses 54,785 38,991
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Income from operations 46,419 3,782
Nonoperating income (expense):
Interest income 230 110
Interest expense (2,216) (452)
------------ ------------
Income before income taxes 44,433 3,440
Income tax expense 17,071 1,122
------------ ------------
Income from continuing operations 27,362 2,318
Cumulative effect of change in accounting principle, net 5,435 -
------------ ------------
Net income $ 32,797 $ 2,318
============ ============
Basic earnings per common share:
Income from continuing operations $ 0.90 $ 0.08
Cumulative effect of change in accounting principle $ 0.18 $ -
------------ ------------
Basic net income per common share $ 1.08 $ 0.08
============ ============
Diluted earnings per common share:
Income from continuing operations $ 0.81 $ 0.08
Cumulative effect of change in accounting principle $ 0.16 $ -
------------ ------------
Diluted net income per common share $ 0.97 $ 0.08
============ ============
Basic weighted average common shares outstanding 30,354 27,786
============ ============
Diluted weighted average common shares outstanding 34,861 28,294
============ ============
Cash dividends declared per share $ - $ -
============ ============
The accompanying notes are an integral part
of these consolidated financial statements.
-4-
ST. MARY LAND & EXPLORATION COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
For the Three Months Ended
March 31,
--------------------------
Reconciliation of net income to net cash provided 2003 2002
by operating activities: ------------ ------------
Net income $ 32,797 $ 2,318
Adjustments to reconcile net income to net
cash provided by operating activities:
(Gain) loss on sale of proved properties (36) 36
Gain on sale of KMOC stock - (836)
Depletion, depreciation and amortization 18,885 13,054
Abandonment and impairment of unproved properties 919 697
Unrealized derivative (gain) loss (115) 352
Deferred income taxes 5,685 840
Exploratory dry hole expense 461 4,178
Minority interest and other 204 (791)
Cumulative effect of change in accounting principle (5,435) -
------------ ------------
53,365 19,848
Changes in current assets and liabilities:
Accounts receivable (32,647) 12,956
Prepaid expenses and other 771 (4,336)
Refundable income taxes 1,031 9,165
Accounts payable and accrued expenses 19,666 4,159
Current deferred income taxes 68 -
------------ ------------
Net cash provided by operating activities 42,254 41,792
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Cash flows from investing activities:
Proceeds from sale of oil and gas properties 108 -
Capital expenditures (21,023) (26,564)
Acquisition of oil and gas properties (73,151) (12,726)
Proceeds from distribution and sale of KMOC stock - 3,114
Other 13 274
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Net cash used in investing activities (94,053) (35,902)
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Cash flows from financing activities:
Proceeds from credit facility 95,820 16,000
Repayment of credit facility (38,820) (60,000)
Proceeds from issuance of convertible notes (62) 96,854
Proceeds from sale of common stock 998 331
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Net cash provided by financing activities 57,936 53,185
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Net change in cash and cash equivalents 6,137 59,075
Cash and cash equivalents at beginning of period 11,154 4,116
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Cash and cash equivalents at end of period $ 17,291 $ 63,191
============ ============
The accompanying notes are an integral part
of these consolidated financial statements.
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ST. MARY LAND & EXPLORATION COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Continued)
Supplemental schedule of additional cash flow information and noncash
investing and financing activities:
For the Three Months Ended
March 31,
--------------------------
2003 2002
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(In thousands)
Cash paid for interest $ 3,809 $ 322
Cash received for income taxes (714) (8,883)
Cash paid for exploration expenses 4,150 6,916
In January 2003 the Company issued 7,200 shares of common stock from
treasury to its non-employee directors and recorded compensation expense
of $153,000.
In January 2002 the Company issued 7,200 shares of common stock to its
non-employee directors and recorded compensation expense of $129,683.
The accompanying notes are an integral part
of these consolidated financial statements.
-6-
ST. MARY LAND & EXPLORATION COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(In thousands, except share amounts)
Accumulated
Common Stock Additional Treasury Stock Other Total
-------------------- Paid-in Retained --------------------- Comprehensive Stockholders'
Shares Amount Capital Earnings Shares Amount Income (Loss) Equity
----------- -------- ------------ ---------- ---------- ---------- ------------- ------------
----------- -------- ------------ ---------- ---------- ---------- ------------- ------------
Balances, December 31, 2001 28,779,808 $ 288 $ 137,384 $ 157,739 (1,009,900) $ (16,210) $ 6,916 $ 286,117
----------- -------- ------------ ---------- ---------- ---------- ------------- ------------
Comprehensive income:
Net Income - - - 27,560 - - - 27,560
Unrealized net loss on marketable
equity securities available for
sale - - - - - - (725) (725)
Reclass to earnings - - - - - - 1,447 1,447
Change in derivative instrument
fair value - - - - - - (14,644) (14,644)
Minimum pension liability
adjustment - - - - - - (761) (761)
------------
Total comprehensive income 12,877
------------
Cash dividends, $ 0.10 per share - - - (2,787) - - - (2,787)
Issuance for Employee Stock
Purchase Plan 18,217 - 344 - - - - 344
ESPP disqualified distribution - - 21 - - - - 21
Sale of common stock, including
income tax benefit of stock
option exerercises 177,085 2 2,743 - - - - 2,745
Accelerated vesing of retiring
director options - - 52 - - - - 52
Directors' stock compensation 8,000 - 144 - - - - 144
----------- -------- ------------ ---------- ---------- ---------- ------------- ------------
Balances, December 31, 2002 28,983,110 $ 290 $ 140,688 $ 182,512 (1,009,900) $( 16,210) $ (7,767) $ 299,513
=========== ======== ============ ========== ========== ========== ============= ============
Comprehensive income:
Net Income - - - 32,797 - - 32,797
Unrealized net loss on marketable
equity securities available for
sale - - - - - - 607 607
Reclass to earnings - - - - - - 6,553 6,553
Change in derivative instrument
fair value - - - - - - (9,428) (9,428)
------------
Total comprehensive income (2,268)
------------
Sale of common stock, including
income tax benefit of stock
option exercises 77,429 1 1,378 - - - 1,379
Directors' stock compensation - - - - 7,200 153 153
----------- -------- ------------ ---------- ---------- ---------- ------------- ------------
Balances, March 31, 2003 29,060,539 $ 291 $ 142,066 $ 215,309 (1,002,700) $ (16,057) $ (10,035) $ 331,574
=========== ======== ============ ========== ========== ========== ============= ============
The accompanying notes are an integral part
of these consolidated financial statements.
-7-
ST. MARY LAND & EXPLORATION COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
------------------------------
March 31, 2003
Note 1 - Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of
St. Mary Land & Exploration Company and Subsidiaries ("St. Mary" or the
"Company") have been prepared in accordance with accounting principles generally
accepted in the United States for interim financial information. They do not
include all information and notes required by generally accepted accounting
principles for complete financial statements. However, except as disclosed
herein, there has been no material change in the information disclosed in the
notes to consolidated financial statements included in St. Mary's Annual Report
on Form 10-K for the year ended December 31, 2002. In the opinion of Management,
all adjustments (consisting of normal recurring accruals) considered necessary
for a fair presentation have been included. Operating results for the period
presented are not necessarily indicative of the results that may be expected for
the full year.
The accounting policies followed by the Company are set forth in Note 1 to
the Company's consolidated financial statements in the Company's Annual Report
on Form 10-K for the year ended December 31, 2002. It is suggested that these
unaudited condensed consolidated financial statements be read in conjunction
with the consolidated financial statements and notes included in the Form 10-K.
Note 2 - Income Taxes
Federal income tax expense for the three months ended March 31, 2003, and
2002 differ from the amounts that would be provided by applying the statutory
U.S. Federal income tax rate to income before income taxes primarily due to
Section 29 credits, percentage depletion, valuation allowance adjustments
against prior year credits, and the effect of state income taxes. At March 31,
2003, the Company's current portion of income tax expense was $11,317,000.
Note 3 - Long-term Debt
In January 2003 the Company entered into a new long-term revolving credit
agreement with a group of banks that replaced the prior credit agreement dated
June 30, 1998. The new credit agreement specifies a maximum loan amount of
$300,000,000. Borrowings under the facility are secured by a pledge of
collateral in favor of the lenders and by common stock of material subsidiaries
of the Company. The borrowing base is currently $275,000,000. The lenders may
periodically re-determine the aggregate borrowing base depending upon the value
of St. Mary's oil and gas properties and other assets. The aggregate commitment
was $150,000,000 at March 31, 2003, and the credit agreement has a maturity date
of January 27, 2006. The Company must comply with certain covenants. Interest
and commitment fees are accrued based on the borrowing base utilization
percentage table below. Interest and commitment fees are accrued based on the
borrowing base utilization percentage table below. Eurodollar loans accrue
interest at LIBOR plus the applicable margin from the utilization table, and ABR
loans accrue interest at Prime plus the applicable margin from the utilization
table.
-8-
Borrowing base
utilization percentage <50% =>50%<75% =>75%<90% >90%
---------------------------------------------------------------------------
Eurodollar Loans 1.25% 1.50% 1.75% 2.00%
ABR Loans 0.00% 0.25% 0.50% 0.75%
Commitment Fee Rate 0.30% 0.38% 0.38% 0.50%
At March 31, 2003, the Company's borrowing base utilization percentage as
defined under the credit agreement was 25.8%. The Company had $68,000,000 in
Eurodollar loans and $3,000,000 in ABR loans outstanding under its revolving
credit agreement and $100,000,000 in outstanding borrowings under the 5.75%
senior convertible notes as of March 31, 2003. The weighted average interest
rate paid for the first quarter of 2003 was 4.88% including commitment fees paid
on the unused portion of the credit facility borrowing base.
Note 4 - Derivative Financial Instruments
The Company realized a net loss of $10,547,000 from its derivative
contracts for the three months ended March 31, 2003, and a net gain of
$3,479,000 for the three months ended March 31, 2002.
The Company's 5.75% senior convertible notes contain a provision for
payment of contingent interest if certain conditions are met. Under Statement of
Financial Accounting Standards ("SFAS") No. 133 this provision is considered an
embedded equity-related derivative that is not clearly and closely related to
the fair value of an equity interest and therefore must be separately treated as
a derivative instrument. The value of the derivative at issuance in March 2002
was $474,000. This amount was recorded as a decrease to the convertible notes
payable in the consolidated balance sheets. Of this amount, $24,000 and $4,000
has been amortized through interest expense for the periods ended March 31,
2003, and March 31, 2002, respectively. Derivative gain in the consolidated
statements of operations includes $128,000 of net gain from mark-to-market
adjustments for this derivative at March 31, 2003, and derivative loss contains
$121,000 of net loss at March 31, 2002.
The Company's previous fixed-rate to floating-rate interest rate swap on
$50,000,000 of 5.75% senior convertible notes did not qualify for cash flow or
fair value hedge treatment under SFAS No. 133. This contract was entered into on
March 25, 2002, and was closed out on December 3, 2002. Derivative loss in the
consolidated statement of operations for the period ended March 31, 2002,
includes $44,000 of net unrealized mark-to-market loss from the interest rate
swap contract.
-9-
The following table summarizes derivative instrument activity.
For the Three Months Ended
March 31,
----------------------------------
2003 2002
---------------- ----------------
Gain (Loss)
Derivative contract settlements included
in oil and gas production revenues $(10,638,000) $3,835,000
Ineffective portion of hedges qualifying
for hedge accounting included in
derivative loss (13,000) (187,000)
Non-qualified derivative contracts included
in derivative gain (loss) 128,000 (165,000)
Amortization of contingent interest derivative
through interest expense (24,000) (4,000)
---------------- ----------------
Total $(10,547,000) $3,479,000
================ ================
Derivative gain in the consolidated statements of operations includes a
loss of $13,000 from ineffectiveness related to hedge contracts in 2003.
Derivative loss in 2002 includes a loss of $187,000 from ineffectiveness related
to hedge contracts. On March 31, 2003, the estimated fair value of contracts
designated and qualifying as cash flow hedges under SFAS No. 133 was a net
pre-tax liability of $15,743,000. The Company will reclassify this amount to
gains or losses included in oil and gas production operating revenues as the
hedged production quantity is produced. Based on current prices the net amount
of existing unrealized after-tax loss as of March 31, 2003, to be reclassified
from accumulated other comprehensive income to oil and gas production operating
revenues in the next twelve months would be $6,303,000, net of deferred income
taxes. The Company anticipates that all original forecasted transactions will
occur by the end of the originally specified time periods.
Note 5 - Compensation Plans
The Company accounts for stock-based compensation using the intrinsic value
recognition and measurement principles prescribed in Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25") and
related interpretations. No stock-based employee compensation expense is
reflected in net income as all options granted under those plans had an exercise
price equal to the market value of the underlying common stock on the date of
grant. The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provisions of SFAS
No. 123, "Accounting for Stock-Based Compensation," to stock-based employee
compensation.
-10-
For the Three Months
Ended March 31,
--------------------
2003 2002
---- ----
(In thousands, except per share amounts)
Net income
As reported $ 32,797 $ 2,318
Pro forma $ 32,497 $ 1,879
Basic earnings per share
As reported $ 1.08 $ 0.08
Pro forma $ 1.07 $ 0.06
Diluted earnings per share
As reported $ 0.97 $ 0.08
Pro forma $ 0.96 $ 0.06
For purposes of pro forma disclosures, the estimated fair values of the
options are amortized to expense over the options' vesting periods. The effects
of applying SFAS No. 123 in the pro forma disclosure are not necessarily
indicative of actual future amounts. Additional awards in future years are
anticipated.
Note 6 - Asset Retirement Obligations
Effective January 1, 2003, the Company adopted the provisions of SFAS No.
143, "Accounting for Asset Retirement Obligations." SFAS No. 143 generally
applies to retirement obligations that result from the acquisition,
construction, development and/or the normal operation of a long-lived asset.
SFAS No. 143 requires the Company to recognize an estimated liability for costs
associated with the abandonment of its oil and gas properties.
As of January 1, 2003, the Company recognized the future cost to abandon
oil and gas properties over the estimated economic life of the oil and gas
properties in accordance with the provisions of SFAS No. 143. A liability for
the fair value of an asset retirement obligation with a corresponding increase
to the carrying value of the related long-lived asset is recorded on a
discounted basis at the time the well is completed or acquired. The Company
depletes the amount added to proved oil and gas properties, net of estimated
salvage values, and recognizes accretion expense in connection with the
discounted liability over the remaining life of the respective oil and gas
properties. The Company previously had recognized an abandonment liability on
its offshore wells. These offshore liabilities were reversed at adoption, and
the methodology described above was used to determine the liability associated
with abandoning all wells, including those offshore.
The estimated liability is based on historical experience in abandoning
these wells, estimated economic lives, estimates as to the cost to abandon the
wells in the future and federal and state regulatory requirements. The liability
is discounted using a discount rate of 7.25%. Revisions to the liability could
occur due to changes in estimated abandonment costs or well economic lives, or
if federal or state regulators enact new requirements for the abandonment of
wells.
Upon adoption of SFAS No. 143, the Company recorded a discounted liability
of $21,403,000, reversed the existing offshore abandonment liability of
$9,144,000, increased net property and equipment by $21,106,000, and recognized
a one-time cumulative effect gain of $5,435,000 (net of deferred tax benefit of
$3,414,000). The Company depletes the amount added to property and equipment and
recognizes accretion expense in connection with the discounted liability over
the remaining economic lives of the respective oil and gas properties.
Prior to the adoption of SFAS No. 143, the Company assumed that salvage
value approximated abandonment costs and therefore salvage value was not
reflected in the DD&A calculation. As a result of adopting SFAS No. 143 and
-11-
the discounting of the asset retirement obligation, the salvage value must now
be reflected in the DD&A rate. Accordingly, $13,728,000 was reversed from
accumulated DD&A and is included as a part of the increase in net property
and equipment in the cumulative effect adjustment. This adjustment to
accumulated DD&A relates to prior depletion of salvage value that would have
been excluded from the DD&A calculation if the abandonment liability had
been separately recognized. As of March 31, 2003, the Company's capitalized
proved oil and gas properties included $42,295,000 of estimated salvage value,
which is not included in the Company's DD&A calculation.
A reconciliation of the Company's liability is as follows (in thousands):
For the Three Months Ended
March 31, 2003
--------------------------
Asset Retirement Obligation at adoption at January 1, 2003 $ 21,403
Liabilities incurred 1,936
Liabilities settled -
Accretion expense 395
Revisions to estimate -
----------------
Asset Retirement Obligation, March 31, 2003 $ 23,734
================
The following table illustrates the effect on the asset retirement
obligation liability, net income and earnings per share if the Company had
adopted the provisions of SFAS No. 143, "Accounting for Asset Retirement
Obligations" on January 1, 2002.
Pro Forma for the Three
Months Ended
March 31, 2002
-----------------------
Asset retirement obligation liability, January 1, 2002 $ 20,355
Asset retirement obligation liability, March 31, 2002 $ 20,709
Net Income
As reported $ 2,318
Pro forma $ 2,079
Basic earnings per share
As reported $ 0.08
Pro forma $ 0.07
Diluted earnings per share
As reported $ 0.08
Pro forma $ 0.07
Note 7 - Flying J Acquisition
On January 29, 2003, the Company acquired oil and gas properties from
Flying J Oil & Gas Inc. and Big West Oil & Gas Inc. (collectively,
"Flying J"). St. Mary issued 3,380,818 shares of its restricted common stock
valued at $71,594,000 for an estimated 66.9 BCFE of proved reserves, $445,000 of
other assets, a $1,936,000 asset retirement liability, a $2,012,000 hedge
liability, and $3,861,000 in cash for net purchase price adjustments. In
-12-
addition, St. Mary made a non-recourse loan to Flying J and Big West of
$71,594,000 at LIBOR plus 2% for up to a 39-month period that is secured by a
pledge of shares of St. Mary common stock issued to Flying J. During the
39-month loan period Flying J and Big West can elect to sell their shares of St.
Mary stock to the Company for $71,594,000 plus accrued interest on the loan for
the first thirty months, and St. Mary can elect to purchase the shares for
$97,447,000, with the proceeds applied to the repayment of the loan and accrued
interest.
These transactions have been accounted for in the accompanying financial
statements as though the properties were purchased for cash. The common stock
that was issued in this transaction has been recorded as temporary equity
because the Company can be required to repurchase these shares. The shares of
common stock are considered outstanding for earnings per share calculations.
These shares could potentially become part of permanent stockholders' equity in
the future. The loan arising from this transaction is considered a
contra-temporary equity item on the consolidated balance sheets, as opposed to
an asset, since the loan is secured by the common stock issued as part of this
transaction. Additionally, because the loan is considered to be contra-equity
and because there are uncertainties related to how the loan will be repaid, no
interest revenue will be recorded in connection with the loan until such
interest is received by the Company.
Note 8 - Earnings Per Share
Basic net income per common share of stock is calculated by dividing net
income by the weighted average of common shares outstanding during each period.
During the first quarter of 2003, the Company issued 3,380,818 shares of common
stock as part of an acquisition (see Note 7). These shares are considered
outstanding for purposes of calculating basic net income per common share and
are weighted accordingly in the calculation of basic common shares outstanding.
Additionally, these shares are included in the temporary equity section of the
accompanying consolidated balance sheets. Following is a reconciliation of total
shares outstanding as of March 31, 2003:
Common shares outstanding in Stockholders' equity 28,057,839
Common shares outstanding in Temporary equity 3,380,818
------------
Total common shares outstanding 31,438,657
============
Diluted net income per common share of stock is calculated by dividing net
income by the weighted average of common shares outstanding and other dilutive
securities. Potentially dilutive securities of the Company consist of
outstanding options to purchase the Company's common stock, shares into which
the convertible notes that were issued in 2002 may be converted, and incremental
shares that would be issued under the reverse-treasury method assumptions if the
put option described in Note 7 is exercised.
The treasury stock method is used to measure the dilutive impact of stock
options. There were 661,389 weighted average outstanding dilutive securities
related to in-the-money options for the three months ended March 31, 2003.
Shares associated with the convertible notes are accounted for using the
if-converted method. Under the if-converted method, income used to calculate
diluted earnings per share is adjusted for the interest charges and
nondiscretionary adjustments based on income that would have changed had the
convertible notes been converted at the beginning of the period. Potentially
dilutive shares of 3,846,153 that relate to the convertible notes were included
in the calculation of diluted net income per share. Shares related to the put
option are accounted for using the reverse-treasury method. There is no dilutive
effect for the put option in the current quarter as the average market value of
the Company's stock exceeded the strike price of the put option.
-13-
Note 9 - Recently Issued Accounting Standards
In April 2003 the Financial Accounting Standards Board ("FASB") issued SFAS
No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities." This Statement amends and clarifies technical aspects of financial
accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities." This Statement is effective for contracts entered into or modified
after June 30, 2003, and for hedging relationships designated after June 30,
2003.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Cautionary Note About Forward - Looking Statements
This Quarterly Report on Form 10-Q includes certain statements that may be
deemed to be "forward-looking statements" within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934. All statements, other than statements of historical facts, included in
this Form 10-Q that address activities, events or developments that St. Mary's
management expects, believes or anticipates will or may occur in the future are
forward-looking statements. Examples of forward-looking statements may include
discussion of such matters as:
o the amount and nature of future capital, development and exploration
expenditures,
o the drilling of wells,
o reserve estimates and the estimates of both future net revenues and the
present value of future net revenues that are included in their
calculation,
o future oil and gas production estimates,
o repayment of debt,
o business strategies,
o expansion and growth of operations,
o recent legal developments, and
o other similar matters.
These statements are based on certain assumptions and analyses made by us
in light of our experience and our perception of historical trends, current
conditions, expected future developments and other factors we believe are
appropriate in the circumstances. Such statements are subject to a number of
assumptions, risks and uncertainties, including such factors as the volatility
and level of oil and natural gas prices, production rates and reserve
replacement, competition, reserve estimates, drilling and operating risks,
uncertainties in cash flow, the availability of attractive exploration and
development and property acquisition opportunities, financing requirements,
expected acquisition benefits, the financial strength of hedge contract counter
parties, litigation, environmental matters, the potential impact of government
regulations, and other matters such as those discussed in the "Risk Factors"
section of our 2002 Annual Report on Form 10-K, many of which are beyond our
control. Readers are cautioned that forward-looking statements are not
guarantees of future performance and that actual results or developments may
differ materially from those expressed or implied in the forward-looking
statements.
Overview
In the quarter ended March 31, 2003, the focus was on oil and gas prices,
the results of our most recent acquisitions and, our success at NE Mayfield
where our share of production has increased from 9MMcf/day a year ago to
-14-
approximately 25MMcf/day currently. The combination of higher prices, a 30%
increase in production and reasonable costs was a formula for record profits in
the first quarter of this year.
We began 2003 with record earnings. Oil and gas prices have since moderated
but they remain very strong. Costs remain moderate. Our drilling program, led by
our recent successes at NE Mayfield, and our acquisition programs are off to a
fast start for the year. We have a solid inventory of prospects to be drilled
and results from the initial well drilled on our Duchesne prospect in the Uinta
Basin will be known within the next few months. With this good start, favorable
industry conditions and our large potential prospect plays we look forward to a
successful 2003.
Critical Accounting Policies and Estimates
We refer you to the corresponding section of our Annual Report on Form 10-K
for the year ended December 31, 2002.
-15-
Results of Operations
The results of operations for the first quarter of 2003 include the impact
of two significant acquisitions, the December 2002 acquisition of Williston
Basin properties from Burlington Resources Oil & Gas Company LP, and the
January 2003 acquisition of oil and gas properties from Flying J Oil & Gas
Inc and Big West Oil & Gas Inc.
The following table sets forth selected operating data for the periods
indicated:
Three Months Ended March 31,
2003 2002
----- -----
In thousands, except per volume data)
Oil and gas production revenues:
Gas production $ 65,931 $ 24,621
Oil production 29,757 16,472
------------- -------------
Total $ 95,688 $ 41,093
============= =============
Net production:
Gas (MMcf) 11,704 9,555
Oil (MBbls) 1,041 705
------------- -------------
MMCFE 17,951 13,785
============= =============
Average sales price (1):
Gas (per Mcf) $ 5.63 $ 2.58
Oil (per Bbl) $ 28.58 $ 23.37
Oil and gas production costs:
Lease operating expense $ 13,872 $ 10,449
Transportation costs 1,389 816
Production taxes 5,869 2,765
------------- -------------
Total $ 21,130 $ 14,030
============= =============
Additional per MCFE data:
Sales price $ 5.33 $ 2.98
Lease operating expense 0.77 0.76
Transportation costs 0.08 0.06
Production taxes 0.33 0.20
------------- -------------
Operating margin $ 4.15 $ 1.96
============= =============
Depletion, depreciation and amortization $ 1.05 $ 0.95
General and administrative $ 0.34 $ 0.23
-------------------
(1) Includes the effects of the St. Mary's hedging activities.
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Oil and Gas Production Revenues. Our quarterly oil and gas production
revenues increased $54.6 million or 133% to $95.7 million for the three months
ended March 31, 2003, compared with $41.1 million for the same period in 2002.
This is the highest quarterly revenue amount in our history. The following table
presents the components of increases between the first quarters of 2003 and
2002:
Production Price Price
% Change $ Change % Change
----------------------------------------------
o Natural Gas 22 % $3.06/Mcf 119 %
o Oil 48 % $5.21/Bbl 22 %
Projections of pricing for oil and natural gas for the remainder of the
year lead us to believe that our average realized price for both will be higher
in 2003 than for comparable periods of 2002. Average net daily production
increased 46.3 MMCFE or 30% to a new quarterly record amount of 199.5 MMCFE for
2003 compared with 153.2 MMCFE in 2002. Our acquisition of properties from
Burlington and Flying J added $15.0 million of revenue and average net daily
production of 30.8 MMCFE to the first quarter of 2003. Wells completed and
properties acquired in the last three quarters of 2002 and during 2003 have
added revenue of $7.6 million and average net daily production of 12.6 MMCFE.
We hedged approximately 58% or 600 MBbls of our oil production for the
three months ended March 31, 2003, and realized a $3.9 million decrease in oil
revenue attributable to hedging compared with a $1.4 million increase in 2002.
Without these contracts our average price would have been $32.35 per Bbl in the
first quarter of 2003 compared to $21.33 per Bbl in 2002. We also hedged 29% of
our 2003 first quarter gas production or 3.8 million MMBtu and realized a $6.7
million decrease in gas revenue compared with a $2.4 million increase in gas
revenue in 2002. Without these contracts our average price would have been $6.20
per Mcf for the three months ended March 31, 2003, compared to $2.66 per Mcf for
the same period in 2002. Current projections of pricing for oil and gas indicate
that we will record net decreases in oil and gas revenues for the remainder of
2003 from hedging contracts we have in place at March 31, 2003.
Marketed Gas Revenue and Expense. For the three months ended March 31,
2003, we received $3.8 million from the sale of marketed natural gas produced by
third parties. Costs associated with these revenues totaled $3.4 million and
resulted in gross margin to us of $416,000. Due to pipeline imbalances, cost
inflation and fluctuations in natural gas prices we may not always have a
positive gross margin from gas marketing activities.
Oil and Gas Production Expenses. Oil and gas production expenses consist of
lease operating expense, production taxes and transportation costs. Total
production expenses increased $7.1 million or 51% to $21.1 million for the three
months ended March 31, 2003, from $14.0 million in 2002. Our acquisition of
properties from Burlington and Flying J added $4.9 million of production costs
in 2003 that were not reflected in 2002.
Total oil and gas production costs per MCFE increased 16% to $1.18 for the
first quarter of 2003 compared with $1.02 for the first quarter of 2002. This
increase is comprised of the following:
o A $0.13 per MCFE increase in production taxes due to higher per MCFE prices.
o A $0.02 increase in transportation costs.
o A $0.01 increase in LOE that reflects our additions of properties in the
higher cost Williston Basin through our acquisitions from Burlington and
Flying J.
As activity on our Burlington and Flying J acquisition properties ramps up
for the summer it is likely that workover LOE will increase. Since production
increases resulting from workover activity are not likely to show up in the
period those costs are incurred, we believe that our LOE per MCFE will increase
during the remainder of 2003. These increases could be offset in part by
decreases in production taxes due to expected decreases in oil and gas prices.
-17-
Depreciation, Depletion, Amortization and Impairment. Depreciation,
depletion and amortization expense ("DD&A") increased $5.8 million or 45% to
$18.9 million for the three months ended March 31, 2003, from $13.1 million in
2002. DD&A expense per MCFE increased by 11% to $1.05 for the first quarter
of 2003 compared with $0.95 in 2002. This increase is a result of
higher-per-unit-cost drilling additions in our gulf and arklatex regions in 2002
and early 2003 of almost $0.09 per MCFE. The remaining increase relates to the
accretion of our asset retirement liability in accordance with Statement of
Financial Accounting Standards No. 143, "Accounting for the Asset Retirement
Obligations."
Exploration. Exploration expense decreased $2.8 million or 40% to $4.2
million for the three months ended March 31, 2003, compared with $6.9 million in
2002. Percentages of total exploration expense are as follows:
2003 2002
---- ----
o Geological and geophysical expenses 34% 11%
o Exploratory dry holes 11% 60%
o Overhead and other expenses 55% 29%
We have budgeted for geological and geophysical expenses and expect to
incur overhead and other expenses in the pursuit of exploration. However, oil
and gas exploration is imprecise, and success can be affected by numerous
factors. Not every likely geologic structure contains oil or natural gas. Even
when oil or natural gas is discovered there are no guarantees that sufficient
quantities can be produced to justify the completion of an exploratory well.
Accordingly, our percentage of exploratory dry hole costs may fluctuate
considerably from period-to-period.
General and Administrative. General and administrative expenses increased
$3.0 million or 96% to $6.1 million for the three months ended March 31, 2003,
compared with $3.1 million in 2002. On a per MCFE basis these costs increased
48% to $0.34 in 2003 from $0.23 in 2002. This increase is primarily due to an
increase in our incentive plan compensation expense caused by the higher prices
we received for production during the first quarter of 2003 compared to 2002.
Prices impact both the current payout amount as well as the mark-to-market
adjustment on the long-term payout amount.
On March 31, 2003, our employee count had increased by 17.5% from March 31,
2002. This change has resulted in a general increase in G&A of $1.3 million
between the two periods. That increase plus a $2.1 million increase in
compensation expense associated with our incentive plans, a $418,000 increase in
accrued charitable contributions expense and a $279,000 increase in insurance
and corporate governance costs were partially offset by a $1.2 million increase
in COPAS overhead reimbursement from operations and G&A we allocated to
exploration expense. As we continue to grow in size and number of personnel we
expect that general and administrative expenses will continue to grow. However,
we expect that first quarter 2003 expense attributable to our incentive plans
was an unusual event due to high prices and that our G&A on a per MCFE basis
will decrease during the rest of 2003.
Interest Expense. Interest expense increased to $2.2 million for the
quarter ended March 31, 2003. This amount reflects accrued interest on our 5.75%
senior convertible notes that were issued in March 2002 and increased borrowing
on our credit facility. We anticipate that interest expense in 2003 will be
higher than the 2002 amount due to the termination of an interest rate swap in
December 2002 that reduced interest expense in 2002 and because we have
increased borrowings on our credit facility.
Income Taxes. Income tax expense totaled $17.1 million for the three months
ended March 31, 2003, and $1.1 million in 2002, resulting in effective tax rates
of 38.4% and 32.6% respectively. The effective rate change from 2002 reflects an
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increase in our highest marginal federal tax rate, the expiration of the Section
29 tax credit, adjustments to valuation allowances to reflect the likelihood
that prior Alternative Minimum Tax credits created by Section 29 credits will
not be used, offset by a decrease in our highest marginal state tax rates and
the 2002 adjustment to valuation allowances against state income taxes from net
operating loss carryovers.
Cumulative Effect of Change in Accounting Principle, net. On January 1,
2003, we adopted SFAS No. 143. The impact of adoption resulted in income to us
of $8.8 million offset by the deferred income tax effect of $3.4 million. See
Note 6 of the Notes to Consolidated Financial Statements under Part I, Item 1 of
this report.
Net Income. Net income for the three months ended March 31, 2003, increased
to $32.8 million compared with $2.3 million in 2002. A 119% increase in gas
prices and a 22% increase in oil prices combined with a 48% increase in oil
production and a 22% increase in gas production resulted in a $54.5 million
increase in oil and gas production revenue between the two periods. We also had
the $5.4 million of income from our adoption of SFAS No. 143. Large changes in
expense items between periods that offset these income items were a $7.0 million
increase in oil and gas production expenses, a $5.8 million increase in DD&A
and a $15.9 million increase in income tax expense.
Liquidity and Capital Resources
Our primary sources of liquidity are the cash provided by operating
activities, debt financing, sales of non-strategic properties and access to the
capital markets. All of these sources can be impacted by significant
fluctuations in oil and gas prices. An unexpected decrease in prices would
reduce expected cash flow from operating activities, might reduce the borrowing
base on our credit facility, could reduce the value of our non-strategic
properties and historically has limited our industry's access to the capital
markets.
We use cash for the acquisition, exploration and development of oil and gas
properties and for the payment of debt obligations, trade payables and
stockholder dividends. Exploration and development programs are generally
financed from internally generated cash flow, debt financing and cash and cash
equivalents on hand. In the event of an unexpected decrease in oil and gas
prices, cash uses such as the acquisition of oil and gas properties and the
payment of stockholder dividends are discretionary and can be reduced or
eliminated. At any given point in time, we may be obligated to pay for
commitments to explore for or develop oil and gas properties or incur trade
payables. However, future obligations can be reduced or eliminated when
necessary. We are currently only required to make interest payments on our debt
obligations. An unexpected increase in oil and gas prices provides flexibility
to modify our uses of cash flow.
We continually review our capital expenditure budget to reflect changes in
current and projected cash flow, acquisition opportunities, debt requirements
and other factors.
Cash Flow. Net cash provided by operating activities increased $462,000 to
$42.3 million for the three months ended March 31, 2003, compared with $41.8
million in 2002. Our $30.5 million increase in net income between the two
periods combined with a $3.0 million increase in the effect of non-cash items
were offset by a $33.1 million change in current assets and liabilities relating
to increased accounts receivables offset by decreased prepaid expenses,
collections of refundable income taxes and increased accounts payable. We
anticipate increased cash flow from operations in 2003 as a result of higher oil
and gas prices in 2003 and increased production attributable to our property
acquisitions in late 2002 and early 2003.
Net cash used in investing activities increased $58.2 million or 162% to
$94.1 million for the three months ended March 31, 2003, compared with $35.9
million in 2002. This increase results from additional capital expenditures and
-19-
acquisition costs and a decrease in receipts of $3.1 million from sales of KMOC
stock. Total capital expenditures, including acquisitions of oil and gas
properties, in the first three months of 2003 increased $54.9 million or 140% to
$94.2 million compared with $39.3 million in the first three months of 2002.
This increase reflects the accounting treatment of the acquisition of properties
from Flying J in January 2003.
Net cash provided by financing activities increased $4.8 million or 9% to
$57.9 million for the three months ended March 31, 2003, compared with net cash
used in financing activities of $53.2 million in 2002. This increase reflects
additional borrowing on our credit facility to fund our 2003 acquisitions.
St. Mary had $17.3 million in cash and cash equivalents and had working
capital of $11.5 million as of March 31, 2003, compared with $11.2 million in
cash and cash equivalents and working capital of $2.1 million at December 31,
2002.
Senior Convertible Notes. In March 2002 we issued in a private placement a
total of $100.0 million of 5.75% senior convertible notes due 2022 with a 0.5%
contingent interest provision. This provision applied to our payment due on
March 15, 2003, and will also apply to our payment due on September 15, 2003.
Interest payments on the notes will be made on March 15 and September 15 in
subsequent years. We received net proceeds of $96.9 million after deducting the
initial purchasers' discount and offering expenses paid by us. The notes are
general unsecured obligations and rank on parity in right of payment with all
our existing and future senior indebtedness and other general unsecured
obligations, and are senior in right of payment with all our future subordinated
indebtedness. The notes are convertible into our common stock at a conversion
price of $26.00 per share, subject to adjustment. We can redeem the notes with
cash in whole or in part at a repurchase price of 100% of the principal amount
plus accrued and unpaid interest including contingent interest beginning on
March 20, 2007. The note holders have the option of requiring us to repurchase
the notes for cash at 100% of the principal amount plus accrued and unpaid
interest including contingent interest upon (1) a change in control of St. Mary
or (2) on March 20, 2007, March 15, 2012 and March 15, 2017. If the note holders
require repurchase on March 20, 2007, we may pay the repurchase price with cash,
shares of our common stock valued at a discount to the market price at the time
of repurchase or any combination of cash and our discounted common stock. We are
not restricted from paying dividends, incurring debt, or issuing or repurchasing
our securities under the indenture for the notes. There are no financial
covenants in the indenture. We used a portion of the net proceeds from the notes
to repay our credit facility balance and used the remaining net proceeds to fund
a portion of our 2002 capital expenditures. On March 25, 2002, we entered into a
five-year fixed-rate to floating-rate interest rate swap on $50.0 million of the
notes. The floating rate was determined at LIBOR plus 0.36%. We elected to
terminate this swap on December 3, 2002, and received proceeds of $4.0 million.
Credit Facility. On January 29, 2003, we entered into a new $300.0 million
credit facility with Wachovia Bank as Administrative Agent and eight other
participating banks. This new credit facility replaced our previous $200.0
million credit facility. The initial calculated borrowing base included
properties we acquired from Flying J Oil & Gas Inc. and Big West Oil &
Gas Inc. The borrowing base is currently $250.0 million. We have accepted an
initial commitment of $150.0 million under this facility. The credit agreement
has a maturity date of January 27, 2006. We are required to comply with certain
covenants that include a current ratio of 1.0 to 1.0, maintenance of ERISA
compliance, and restrictions on additional indebtedness, sales of oil and gas
properties, activities outside our ordinary course of business and certain
merger transactions. Interest and commitment fees are accrued based on the
borrowing base utilization percentage table below. Eurodollar loans accrue
interest at LIBOR plus the applicable margin from the utilization table, and ABR
loans accrue interest at Prime plus the applicable margin from the utilization
table.
-20-
Borrowing base
utilization percentage <50% =>50%<75% =>75%<90% >90%
---------------------------------------------------------------------------
Eurodollar Loans 1.25% 1.50% 1.75% 2.00%
ABR Loans 0.00% 0.25% 0.50% 0.75%
Commitment Fee Rate 0.30% 0.38% 0.38% 0.50%
Our loan balance accrued interest at LIBOR plus 1.25% on March 31, 2003. As
of March 31, 2003, and December 31, 2002, $71.0 million and $14.0 million
respectively were outstanding under our credit facilities.
Schedule of Contractual Obligations. The following table summarizes our
future estimated principal payments for the periods specified (in millions):
Long-Term Debt Operating Leases Total Cash Obligation
---------------------------------------------------------------
Less than 1 year $ - $1.5 $ 1.5
1-3 years 71.0 2.4 73.4
4-5 years - 1.8 1.8
After 5 years 100.0 3.5 103.5
---------------------------------------------------------------
Total $171.0 $9.2 $180.2
===============================================================
In the next three years, we have office space leases for two of our
regional offices that will expire. Two additional leases for office space will
expire in years 4-5. Estimated costs to replace these leases are not included in
the table above. For purposes of the table we assume that the holders of our
senior convertible notes will not exercise the conversion feature.
Common Stock. In August 1998 St. Mary's Board of Directors authorized a
stock repurchase program whereby we may purchase from time-to-time, in open
market transactions or negotiated sales, up to two million of our common shares.
Through March 31, 2003, we have repurchased a total of 1,009,900 shares of St.
Mary's common stock under the program for $16.2 million at a weighted average
price of $15.86 per share, net of put option sale premiums received. We
anticipate that additional purchases of shares may occur as market conditions
warrant. Any future purchases will be funded with internal cash flow and
borrowings under our credit facility.
On January 29, 2003, we issued a total of 3,380,818 restricted shares of
our common stock valued at $71.6 million to Flying J Oil & Gas Inc. and Big
West Oil & Gas Inc. for the acquisition of oil and gas properties, and we
made a non-recourse loan to Flying J and Big West in the amount of $71.6 million
at LIBOR plus 2% for up to a 39-month period. The loan is secured by a pledge of
the 3,380,818 shares and during the 39-month loan period Flying J and Big West
can elect to sell these shares to St. Mary for $71.6 million plus accrued
interest on the loan for up to the first 30 months, and we can elect to
repurchase the shares for $97.4 million with the proceeds applied to repayment
of the loan. The shares are subject to contractual restrictions on transfer for
a period of two years. Flying J and Big West cannot increase their ownership
percentage in St. Mary for a period of 30 months. For accounting purposes the
stock and the loan are reflected in the temporary equity section of our
consolidated balance sheets. Because the loan is reflected in temporary equity
we will not record interest income from the loan until such time as Flying J and
Big West make actual payment of the interest to us. At March 31, 2003, the
cumulative amount of interest accrued but not recorded as income by us was
$417,000.
Capital and Exploration Expenditures Incurred. Expenditures for exploration
and development of oil and gas properties and acquisitions are the primary use
of our capital resources. The following table sets forth certain information
regarding the costs incurred by us in our oil and gas activities during the
periods indicated.
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Capital and Exploration Expenditures
------------------------------------
Three Months Ended March 31,
----------------------------
2003 2002
---- ----
(In thousands)
Development $ 20,575 $ 16,348
Exploration 7,507 4,872
Acquisitions:
Proved 76,466 10,023
Unproved 1,891 4,277
--------- --------
Total $ 106,439 $ 35,520
========= ========
We continuously evaluate opportunities in the marketplace for oil and gas
properties and, accordingly, may be a buyer or a seller of properties at various
times. We will continue to emphasize smaller niche acquisitions utilizing our
technical expertise, financial flexibility and structuring experience. In
addition, we are also actively seeking larger acquisitions of assets or
companies that would afford opportunities to expand our existing core areas, to
acquire additional geoscientists or to gain a significant acreage and production
foothold in a new basin.
St. Mary's total costs incurred in the first quarter of 2003 increased
$70.9 million or 200% compared to the first quarter of 2002. We spent $30.0
million in the first quarter of 2003 for unproved property acquisitions and
domestic exploration and development compared to $25.5 million for the
comparable quarter in 2002.
We continue to evaluate the results of our two coalbed methane pilot
programs located in the Hanging Woman Basin. On April 30, 2003, the Bureau of
Land Management issued its record of decision approving the two environmental
impact statements that considered coalbed methane development in northeast
Wyoming and southeast Montana. We hope the two environmental impact statements
will open the door for new coalbed methane development on federal acreage in
this area of Wyoming and Montana. Immediately after the decision was issued
several environmental groups filed multiple challenges. These challenges and a
previously reported environmental public interest group lawsuit affect 89,700
gross acres related to this project.
In December 2002 we purchased oil and gas properties from Burlington
Resources Oil & Gas Company LP for $69.5 million in cash. The acquisition
cost does not include an adjustment for SFAS No. 143 Asset Retirement
Obligations. The ARO for the Burlington acquisition was included in our initial
SFAS No. 143 adoption entry. The properties are located in the Williston Basin
of Montana and North Dakota with extensive overlap of ownership interest. Most
of the properties will be operated by our Nance Petroleum Corporation subsidiary
and are very concentrated in a manageable well count with high ownership
percentages in high quality long-lived properties. We financed this acquisition
using cash on hand and a portion of our bank credit facility. At the time of
acquisition, these properties were producing an estimated 3,100 Bbls of oil per
day and 3,300 Mcf of natural gas per day.
Through March 31, 2003, we have utilized our common stock, cash on hand and
a portion of our new credit facility to acquire $78.8 million of oil and gas
properties, other equipment and inventory. On January 29, 2003, we closed an
acquisition of 66.9 BCFE of oil and gas properties and $445,000 of other
equipment and inventory for $71.7 million. We used $71.6 million of restricted
shares of our common stock, we assumed a $2.0 million hedge liability and we
assumed a $1.9 million SFAS No. 143 ARO from Flying J Oil & Gas Inc. and Big
West Oil & Gas Inc. We received $3.8 million of cash for net purchase price
adjustments. See the Common Stock section above for additional details. Half of
the value of the properties acquired is located in the Williston Basin. The
remaining value is split between the Powder River, Wind River and Green River
-22-
Basins of Wyoming and represents a significant increase in our presence in these
areas.
Capital Expenditure Budget. We anticipate spending approximately $225
million for capital and exploration expenditures in 2003 with $90 million for
acquisitions, which includes the $71.6 million acquisition of properties from
Flying J in January 2003. Budgeted ongoing exploration and development
expenditures in 2003 for each of our core areas is as follows (in millions):
o Mid-Continent region $ 45
o Williston Basin and Rockies region 33
o ArkLaTex region 19
o Gulf Coast and Gulf of Mexico region 17
o Permian Basin 12
o Other 9
----
Total $ 135
====
We believe the amount not funded from our internally generated cash flow in
2003 can be funded from our existing cash and our credit facility. The amount
and allocation of future capital and exploration expenditures will depend upon a
number of factors including the number and size of available acquisition
opportunities and our ability to assimilate these acquisitions. Also, the impact
of oil and gas prices on investment opportunities, the availability of capital
and borrowing capability and the success of our development and exploratory
activity could lead to funding requirements for further development. If
additional development or attractive acquisition opportunities arise, we may
consider other forms of financing, including the public offering or private
placement of equity or debt securities.
We seek to protect our rate of return on acquisitions of producing
properties by hedging cash flow when the economic criteria from our evaluation
and pricing model indicate it would be appropriate. Management's strategy is to
hedge cash flows from investments requiring a gas price in excess of $3.25 per
Mcf and an oil price in excess of $22.50 per Bbl in order to meet minimum
rate-of-return criteria. Management reviews these hedging parameters on a
quarterly basis. We anticipate this strategy will result in the hedging of
future cash flows from acquisitions. We generally limit our aggregate hedge
position to no more than 50% of total production but will hedge larger
percentages of total production in certain circumstances. We seek to minimize
basis risk and index the majority of oil hedges to NYMEX prices and the majority
of gas hedges to various regional index prices associated with pipelines in
proximity to our areas of gas production. Our cash flow hedging instruments
generally qualify for cash flow hedge accounting under SFAS No. 133. Our policy
requires that we diversify our hedge positions with various counterparties and
requires that such counterparties have clear indications of current financial
strength. Including hedges entered into since March 31, 2003, we have the
following swaps and collars in place:
-23-
Swaps
-----
Average Quantity Average Fixed
Product Volumes/month Type Contract Price Duration
------------------------------------------------------------------------------------------
Natural Gas 1,834,000 MMBtu $4.48 04/03 - 12/03
Natural Gas 869,000 MMBtu $4.08 01/04 - 12/04
Oil 208,100 Bbls $25.95 04/03 - 12/03
Oil 144,500 Bbls $23.71 01/04 - 12/04
Collars
-------
Average Floor Ceiling
Product Volumes/month Price Price Duration
------------------------------------------------------------------------------------------
Natural Gas 152,000 MMbtu $2.50 $5.96 04/03 - 12/03
Derivative gain in the statements of operations includes $13,000 of net
loss from oil and gas ineffectiveness compared to $187,000 net loss included in
derivative loss at March 31, 2002.
Other Derivatives: Our 5.75% senior convertible notes contain a provision
for payment of contingent interest if certain conditions are met. Under SFAS No.
133 this provision is considered an embedded equity-related derivative that is
not clearly and closely related to the fair value of an equity interest and
therefore must be separated and accounted for as a derivative instrument. The
value of the derivative at issuance in March 2002 was $474,000. This amount was
recorded as a decrease to the convertible notes payable in the consolidated
balance sheets. Of this amount, $24,000 has been amortized through interest
expense. Derivative gain in the consolidated statements of operations includes
$128,000 of net gain from mark-to-market adjustments for this derivative at
March 31, 2003, compared to a net loss of $121,000 included in derivative loss
at March 31, 2002.
The fixed-rate to floating-rate interest rate swap on $50 million of senior
convertible notes that we closed in December 2002 did not qualify for fair value
hedge treatment under SFAS No. 133. Unrealized derivative loss in the
consolidated statements of operations includes $44,000 of net loss in 2002 from
mark-to-market adjustments for this derivative.
Accounting Matters
New Accounting Standards
In April 2003 the Financial Accounting Standards Board ("FASB") issued
SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities." This Statement amends and clarifies technical aspects of financial
accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities." This Statement is effective for contracts entered into or modified
after June 30, 2003, and for hedging relationships designated after June 30,
2003. In addition, except in certain limited circumstances, all provisions of
this Statement should be applied prospectively.
On January 1, 2003, we adopted SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." We do not have any pending or
planned exit or disposal activities, and there was no material effect on our
financial position or results of operations from the adoption of this statement.
-24-
On January 1, 2003, we adopted SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." There was no impact on our financial position or results of
operations as a result of the adoption of this statement.
Effective January 1, 2003, we adopted the provisions of SFAS No. 143,
"Accounting for Asset Retirement Obligations." Upon adoption of SFAS No. 143, we
recorded a discounted liability of $21.4 million, reversed the existing offshore
abandonment liability of $9.1 million, increased net property and equipment by
$21.1 million and recognized a one-time cumulative effect gain of $5.4 million
(net of deferred tax benefit of $3.4 million). We will deplete the amount added
to property and equipment and recognize accretion expense in connection with the
discounted liability over the remaining economic lives of the respective oil and
gas properties. Prior to the adoption of SFAS No. 143, we assumed that salvage
value approximated abandonment costs and therefore salvage value was not
reflected in the DD&A calculation. As a result of adopting SFAS No. 143 and
the discounting of the asset retirement obligation, the salvage value must now
be reflected in the DD&A rate. Accordingly, $13.7 million was reversed from
accumulated DD&A and is included as a part of the increase in net property
and equipment in the cumulative effect adjustment. This adjustment to
accumulated DD&A relates to prior depletion of salvage value that would have
been excluded from the DD&A calculation if the abandonment liability had
been separately recognized. As of March 31, 2003, our capitalized proved oil and
gas properties included $42.3 million of estimated salvage value, which is not
included in our DD&A calculation.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
We hold derivative contracts and financial instruments that have cash flow
and net income exposure to changes in commodity prices or interest rates.
Financial and commodity-based derivative contracts are used to limit the risks
inherent in some crude oil and natural gas price changes that have an effect on
us.
Our board of directors has adopted a policy regarding the use of derivative
instruments. This policy requires every derivative used by St. Mary to relate to
underlying offsetting positions, anticipated transactions or firm commitments.
It prohibits the use of speculative, highly complex or leveraged derivatives.
Under the policy, the Chief Executive Officer and Vice President-Finance
implement all risk management programs that use derivatives. These programs are
approved by the board of directors and the audit committee.
Commodity Price Risk. We use various hedging arrangements to manage our
exposure to price risk from natural gas and crude oil production. These hedging
arrangements have the effect of locking in for specified periods, at
pre-determined prices or ranges of prices, the prices we will receive for the
volumes to which the hedge relates. Consequently, while these hedging
arrangements are structured to reduce our exposure to decreases in prices
associated with the hedged commodity, they also limit the benefit we might
otherwise receive from any price increases associated with the hedged commodity.
The derivative gain or loss effectively offsets the loss or gain on the
underlying commodity exposures that have been hedged. The fair value of the
swaps are estimated based on quoted market prices of comparable contracts and
approximate the net gains or losses that would have been realized if the
contracts had been closed out at quarter-end. The fair values of the futures are
based on quoted market prices obtained from the New York Mercantile Exchange,
adjusted for basis differentials.
For contracts in place on March 31, 2003, a hypothetical $0.10 change in
the future NYMEX strip prices applied to a notional amount of 26.1 million MMBtu
covered by natural gas swaps and collars would cause a change in the gain or
(loss) from these contracts of $1.4 million in 2003 and $917,000 in 2004. A
hypothetical $1.00 change in future NYMEX oil prices applied to a notional
amount of 3.6 MMBbls covered by crude oil swaps would cause a change in the gain
or (loss) from these contracts of $1.8 million in 2003 and $1.6 million in 2004.
-25-
These hypothetical changes were discounted to present value using a 7.5%
discount rate since the latest expected maturity date of certain swaps and
futures contracts is greater than one year from the reporting date.
Interest Rate Risk. Market risk is estimated as the potential change in
fair value resulting from an immediate hypothetical one-percentage point
parallel shift in the yield curve. A sensitivity analysis presents the
hypothetical change in fair value of those financial instruments held by St.
Mary at March 31, 2003, which are sensitive to changes in interest rates. For
fixed-rate debt, interest rate changes affect the fair market value but do not
impact results of operations or cash flows. Conversely for floating rate debt,
interest rate changes generally do not affect the fair market value but do
impact future results of operations and cash flows, assuming other factors are
held constant. The carrying amount of our floating rate debt approximates its
fair value. At March 31, 2003, we had floating-rate debt of $71.0 million and
had $100.0 million of fixed-rate debt. Assuming constant debt levels, the cash
flow impact for the remainder of the year resulting from a one- percentage point
change in interest rates would be approximately $532,000 before taxes. The
results of operations impact might be less than this amount as a direct effect
of the capitalization of interest to wells drilled during the rest of the year.
In prior years when our debt amount was at a reduced level we capitalized a
large portion of our interest expense. Since we cannot predict the exact amount
that would be capitalized, we cannot predict the exact effect that a
one-percentage point shift would have on our results of operations.
ITEM 4. CONTROLS AND PROCEDURES
We maintain a system of disclosure controls and procedures that are
designed for the purposes of ensuring that information required to be disclosed
in our SEC reports is recorded, processed, summarized and reported within the
time periods specified in the SEC's rules and forms, and that such information
is accumulated and communicated to our management, including the Chief Executive
Officer and the Vice-President - Finance, as appropriate to allow timely
decisions regarding required disclosure.
Within the 90-day period prior to the filing of this report, we carried out
an evaluation, under the supervision and with the participation of our
management, including the Chief Executive Officer and the Vice-President -
Finance, of the effectiveness of the design and operation of our disclosure
controls and procedures. Based upon that evaluation, the Chief Executive Officer
and the Vice-President - Finance concluded that our disclosure controls and
procedures are effective for the purposes discussed above. There have been no
significant changes in our internal controls or in other factors that could
significantly affect these controls subsequent to the date of the evaluation.
-26-
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
-----------------
The previously reported legal proceeding involving Nance Petroleum
Corporation and the Northern Plains Resource Council, Inc. in the U.S. District
Court for the District of Montana had no significant developments during the
quarterly period ended March 31, 2003. For a description of this proceeding,
please see the "Legal Proceedings" section of St. Mary's Annual Report on Form
10-K for the year ended December 31, 2002.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
-----------------------------------------
(c) On January 23, 2003, St. Mary issued a total of 7,200 restricted shares
of common stock from treasury to its non-employee directors as
compensation recorded in the amount of $153,000 for their services as
members of the board of directors. These shares were not registered
under the Securities Act of 1933 in reliance on Rule 506 of Regulation
D promulgated under the Securities Act since the directors are
accredited investors and certificates representing the shares bear a
legend restricting the transfer of those shares.
On January 29, 2003, St. Mary issued a total of 3,380,818 restricted
shares of common stock to Flying J Oil & Gas, Inc. and Big West Oil
& Gas, Inc. for the acquisition of oil and gas properties recorded
in the amount of $71,594,000. For further information concerning this
transaction, see Note 7 of the Notes to Consolidated Financial
Statements under Part I, Item 1 of this report. These shares were not
registered under the Securities Act of 1933 in reliance on Rule 506 of
Regulation D promulgated under the Securities Act since Flying J and
Big West are accredited investors and certificates representing the
shares bear a legend restricting the transfer of those shares.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
(a) Exhibits
--------
The following exhibits are furnished as part of this report:
Exhibit
Number Description
------ -----------
3.1 Amendments to St. Mary Land & Exploration Company By-Laws
adopted on March 27, 2003.
3.2 Restated By-Laws of St. Mary Land & Exploration Company as
amended on March 27, 2003.
99.1 Certifications Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 (submitted as an Exhibit to accompany this report
pursuant to interim guidance by the SEC in SEC Release Nos.
33-8212 and 34-47551).
(b) Reports on Form 8-K
St. Mary Land & Exploration Company filed the following current
year reports on form 8-K during the quarter ended March 31, 2003:
On January 28, 2003, we filed a current report on Form 8-K
reporting under Item 9 that we had issued a press release announcing
our capital expenditures budget, year-end 2002 reserves and an update
of fourth quarter 2002 operations.
-27-
On January 28, 2003, we filed a current report on Form 8-K
reporting under Item 5 that we had issued a press release announcing
the discovery of a clerical error.
On February 13, 2003, we filed a current report on Form 8-K
reporting under Item 2 that we had acquired properties from Flying J
Oil & Gas Inc. and Big West Oil & Gas Inc. We also reported
under Item 5 that we had entered into a new $300 million credit
facility.
On February 27, 2003, we filed a current report on Form 8-K
reporting under Item 9 that we had issued a press release announcing
our 2002 financial results and an updated forecast for the first
quarter and full year of 2003.
On March 31, 2003, we filed a current report on Form 8-K
reporting under Item 5 that we had issued a press release announcing
the accrual of additional contingent interest on our 5.75% senior
convertible notes.
-28-
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
ST. MARY LAND & EXPLORATION COMPANY
May 14, 2003 By /s/ MARK A. HELLERSTEIN
-----------------------------------
Mark A. Hellerstein
President and Chief Executive Officer
May 14, 2003 By /s/ RICHARD C. NORRIS
-----------------------------------
Richard C. Norris
Vice President - Finance, Secretary
and Treasurer
May 13, 2003 By /s/ GARRY A. WILKENING
-----------------------------------
Garry A. Wilkening
Vice President - Administration and
Controller
CERTIFICATION
I, Mark A. Hellerstein, certify that:
1. I have reviewed this quarterly report on Form 10-Q of St. Mary Land
& Exploration Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003
/s/ MARK A. HELLERSTEIN
--------------------------
Mark A. Hellerstein
Chief Executive Officer
CERTIFICATION
I, Richard C. Norris, certify that:
1. I have reviewed this quarterly report on Form 10-Q of St. Mary Land
& Exploration Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003
/s/ RICHARD C. NORRIS
----------------------
Richard C. Norris
Vice President-Finance